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With a promise of more stable returns, lesser risk, and minimal volatility than equity funds, debt mutual funds are a viable investment choice for those who want optimal returns in a short duration. These funds typically invest in securities like T-bills, Government securities, corporate bonds, commercial paper, and other money market instruments.
However, investing in debt funds can be a little daunting for an investor, given the sheer number of profitable schemes to choose from. A wrong fund choice can increase the risk of lower returns or poor portfolio performance.
Even though debt funds bring you relatively safer returns than equity funds, there are various factors you must consider before investing. So, here’s how you can select a suitable debt mutual fund:
The first step is to pick the right debt fund category based on your risk tolerance and the time horizon of your financial goals.
With debt funds, you get to choose from 16 different sub-categories of funds based on credit rating, residual maturity, portfolio constituents, and more. For instance, banking and PSU funds hold a minimum of 80% of their funds in banks, PSUs, and public financial institutions. At the same time, credit risk funds have to invest at least 65% of their portfolio in below AA-rated instruments.
These classifications can help you choose the right fund category and pick the best fund as per your goals.
A debt fund’s average maturity is the weighted average of all the maturities of the debt securities in it. During a falling interest rate regime, debt funds with a higher average maturity tend to perform better, as any short-term losses can be settled in the long run.
Alternatively, debt funds with lower average maturities offer better outcomes during rising interest rate scenarios. This helps you perfectly match your investment goals with that of the fund’s maturity and avoid unnecessary risks.
Interest rate risk is fluctuation in price of bond due to change in interest rate in an economy. Interest rates significantly impact the returns on debt mutual funds. When the interest rate rises, the bond price declines, and vice versa. For instance, suppose a bond is offering 10% annual coupon. Now, if the interest rates decline, new bonds will start giving lower coupon, say 9%. This results in high demand for old bond offering 10% coupon. This leads to a rise in the price of the bond and, as a result, the NAV of the debt fund holding it rises.
Debt mutual funds with higher average maturity are more prone to interest rate risk compared to shorter term debt mutual funds.
Another crucial factor in ensuring investment in the best debt fund is its credit rating. All debt instruments and bonds are assigned a credit rating by different agencies based on their repayment ability. Instruments rated AAA are considered the best options and indicate a safe investment.
You can also choose from AA or AA+ instruments for investment or go even lower if you want returns and don’t mind a little risk.
To make smarter investment decisions, rely on both current and historical performances of the debt fund. Studying a fund’s past performance gives you a fair indication of its returns performance parameters and helps you understand the overall market conditions. Without in-depth knowledge of a fund’s history, you’ll end up exposing yourself to higher risk.
That said, past performance shouldn’t be the only parameter while making your investment decision. Dig deeper and consider the portfolio spread, credit risk, interest rate cycle and reputation of the asset management company.
The expense ratio is the percentage of the fund’s assets used to manage the fund’s expenses. The lower the expense ratio of the fund, the higher the returns you receive.
While debt funds are less risky than equity funds, they still carry risk. So, make sure to consider the above-mentioned factors before making an investment decision and maximise your returns.
When you’re ready to start your mutual fund journey, get in touch with us at Tata Capital Wealth. We offer a wide range of tailor-made investment, protection, and financial products to help you meet your long-term goals.
Visit our website to know more.
Policies, Codes & Other Documents